Saturday, June 30, 2012

A cross-country meta-study of health care delivery in low and middle-income countries by public and private sectors questions the conventional wisdom that the private sector is more efficient, accountable, or medically effective than the public sector.

This finding goes against the grain of mainstream thinking that the path towards achieving greater effectiveness in health care services delivery lies in increasing private participation. It goes further and raises concerns that the private sector may be cornering an increasing share of the scarce public resources being spent on health care, thereby depriving public systems off investments. This is apart from the competitive dynamics between both sectors and the deeper pockets of the private sector crowding in specialist medical practitioners.

The study evaluated both types of health care systems across developing countries based on the six WHO health systems framework themes - accessibility and responsiveness; quality; outcomes; accountability,
transparency, and regulation; fairness and equity; and efficiency. The authors find from the comparative cohort and cross-sectional study,

Providers in the
private sector more frequently violated medical standards of practice
and had poorer patient outcomes, but had greater reported timeliness and
hospitality to patients... the private sector appeared to have lower efficiency than the public
sector, resulting from higher drug costs, perverse incentives for
unnecessary testing and treatment, greater risks of complications, and
weak regulation... Public sector services
experienced more limited availability of equipment, medications, and
trained healthcare workers. When the definition of "private sector"
included unlicensed and uncertified providers such as drug shop owners,
most patients appeared to access care in the private sector; however,
when unlicensed healthcare providers were excluded from the analysis,
the majority of people accessed public sector care. "Competitive
dynamics" for funding appeared between the two sectors, such that public
funds and personnel were redirected to private sector development,
followed by reductions in public sector service budgets and staff.

Since private sector is in general associated with superior outcomes, in case of healthcare with treatment outcomes, the paper's finding to the contrary comes as a big surprise. It writes,

Public sector provision was associated with higher rates of treatment success for tuberculosis and HIV as well as vaccination.
For example, in Pakistan, a matched cohort study in Karachi found that
public sector tuberculosis care resulted in an 85% higher treatment
success rate than private sector care... In South Korea, tuberculosis treatment success rates were 51.8% in
private clinics as opposed to 79.7% in public clinics, with only 26.2%
of patients in private clinics receiving the recommended therapy, and
over 40% receiving an inappropriately short duration of therapy...

In India, an analysis of over 120,000 households, adjusted for
demographic and socioeconomic factors, found that children receiving
private health services were less likely to receive measles vaccinations. Similar findings were reported from Cambodia. Studies
comparing pre- and post-privatization outcomes tended to find worse
health system performance associated with rapid and extensive healthcare
privatization initiatives. In Colombia, following major privatization
reforms in 1993, population vaccine coverage declined for several
diseases in the country, and tuberculosis incidence rose significantly.
In Brazil, privatization of fertility control services led to increased
abortions, sterilization, and improper use of oral contraceptives
(obtained without medical consultation), ultimately linked to higher
mortality rates among young women.

Interestingly the study questions the claims of private sector superiority in studies by organization like the World Bank,

The World Bank has made strong claims that investing in public–private partnerships will improve efficiency and effectiveness in the health sector, yet several of its publications revealed that these assertions were either unsupported by data or the data was not provided in sufficient detail to pass minimal inclusion criteria required for this review... Despite the lack of data about private sector performance, recent
initiatives by the World Bank's International Finance Committee are
underwriting the expansion of private sector services among low- and
middle-income countries. For example, in sub-Saharan Africa, the
International Finance Committee has created a private equity fund to
make 30 long-term investments in private health companies. These
conflicts of interest pose a potential threat to the validity of World
Bank–sponsored studies and raise the need for independent scrutiny.

The exhaustive findings of the study should serve as a strong reminder about the limitations of privatization of essential services like health care. This is especially true of developing countries where private markets are constrained by lack of adequate breadth and depth on both the supply and demand sides. On the one hand, supply-side competition is limited, while on the other hand, demand side affordability and ability to pay are questionable. Both these contribute to several distortions and inefficiencies.

Friday, June 29, 2012

A study by Lloyds TSB International (via FT) has found that India has seen the biggest rise in housing prices of any country in the world in the ten years from 2001 to 2011. In fact, emerging economies had four of the six top performers.

Real housing prices (adjusted for CPI) in India grew a staggering 284% over the 10-year period. This is almost six times the 50% rise in real UK house prices over the same period and over 10 times the 23% rise seen in the Euro area.

Annualized, this translated into a real growth of 14.4% for the decade.

While the spectacular increase is a reflection of the dramatic rise in the country's GDP - it rose 280% over the same period - it also a reflection of certain fundamental regulatory problems in a massive country where urbanization is proceeding at a very fast clip and urban land reserves are depleting very fast.

Thursday, June 28, 2012

Saving the eurozone is undoubtedly the biggest challenge facing the world economy today. Stabilizing the panic-gripped Eurozone financial markets is the first step in this process. However, an acrimonious debate is raging about how this should be carried out, in particular about Germany's financial contribution to this process.

On the one hand are those who claim that Germany should write a blank cheque to save the Eurozone for atleast two reasons. One, it is the strongest and the only country capable of providing the financial backstop given the magnitude of the task. Two, it has been the biggest beneficiary of the single currency project and therefore should now be willing to return the favor when the others are struggling. Eduardo Porter, pointing to Germany's relative economic strength amidst the dismal performances of its neighbours, summarized this claim in a recent NYT column,

Germany must ultimately underwrite the euro’s rescue, pretty much
regardless of whether its conditions are satisfied. There are three good
reasons. First, the euro has been very good to Germany. Second, the
bailout costs are likely to be much lower than most Germans believe.
Third, and perhaps most important, the cost to Germany of euro
dismemberment would be incalculably high — far more than that of keeping
the currency together.

Germany has had a fairly good crisis so far...
Since 2009 it has grown faster and
suffered less unemployment than almost any other industrialized country... Germany owes much of this to the euro — which tethered its
ultracompetitive manufacturing to the mediocre economies of its
neighbors. Since the advent of the single currency, Germany’s labor
costs have fallen more than 15 percent against the average labor costs
of all the countries using the euro, and about 25 percent against those
of the troubled nations on the periphery. If it dumped the euro for a
new deutsche mark, its exchange rate would surge to make up for the
difference, potentially crippling its exports, which have fed most of
its economic growth over the last decade.

Others, especially the German government, strongly contest this claim. Apart from disputing the figures themselves, they point to the unfairness of asking Germany to pay for the sins (after all asset bubbles, consumption booms, and reckless government spending are all domestic sins) committed by other countries. They also claim that rewarding such behaviour will generate moral hazard and will only prevent the hard measures required by the peripheral countries to rebalance their economies. Gunnar Beck recently wrote,

Between 1998 and 2011, German exports grew by 117
percent, according to the Federal Statistical Office... German
exports rose most — by 154 percent — to the rest of the world; by 116
percent to non-euro E.U. members; and least of all, 89 percent, to other
euro zone members. In 1998 the euro zone still accounted for 45 percent
of all German exports; in 2011 that share had declined to 39 percent. These trends are continuing. The euro zone remains very important to
Germany’s export trade, but it is hardly the motor of growth.

Between 1995 and 2008, Germany saved more than most, yet it exhibited
the lowest net investment rate of all O.E.C.D. countries. On average,
from 1995 to 2008, 76 percent of aggregate German savings (private,
governmental and corporate) were invested abroad... Germany bled
capital in the years before the euro crisis — capital that fueled an
unprecedented economic boom in the southern euro zone that spread out
from their real-estate markets to the general economy.

Between 1995 (the year when the details for monetary union were
finalized and the single currency effectively launched) and 2011,
Germany had the second-lowest growth rate in G.D.P. among all European
countries, according to Eurostat... growth was equally below the European/E.U. average for the
period 1998 to 2011... Over the period
from 1998 to 2011, only Japan, Italy, Portugal and Greece performed
worse than Germany. This is not the performance of a euro-winner.

He also points to the staggering size of the blank cheque that Germany is being forced to write to save the Eurozone,

According to Hans Werner Sinn, Germany’s total exposure currently amounts to over
€700 billion, or about one third of Germany total public debt of around
€2.09 trillion. If and when Germany’s losses have to be realized,
Germany’s aggregate public debt could quickly approach Portuguese or
Italian levels and, in a worse-case scenario, rise well in excess of 110
percent of G.D.P.

Given the spiralling borrowing costs of Spain and Italy, it is undeniable that some form of backstop facility through a lender of last resort has to emerge to prevent their sovereign defaults. Given the size of these economies - nearly $1.5 trillion in debts coming due till 2015 - and the possibility of contagion spreading to others, one-off bailout funds may not be able to do too much to stem the plunge. In fact, it may become a case of throwing good money down the drain.

In the circumstances, all the major economies, apart from Germany, are now calling for some form of Eurobonds or debt mutualization, wherein the Eurozone balance sheet is used to let Spain and Italy raise money to refinance their debts. In simple terms, this would be leveraging the strength and credibility of the German economy to subsidize the borrowing costs for all others.

Germany naturally opposes any such arrangement and warns that it generates dangerous moral hazard. A Times article captures Germany's response to this arguement,

Germany has not ruled out the issuance of so-called euro bonds, which
would be backed by the euro zone as a whole, not its individual member
states, thereby presumably making the bonds more attractive to
investors. But Germany insists that if it is to share risk with other
nations, their governments should cede more control over their spending
and borrowing. This is highly controversial in a number of euro zone countries, most
notably France, where preserving national sovereignty is a central
concern.

Germany's concerns and the attendant precondition is justifiable. At the least, such debt mutualization has to be accompanied with a pan-European banking regulator with powers to supervise and take decisions regarding individual national banks and national governments being willing to cede some control over their national budgets. At best, there should be a Eurozone wide banking and fiscal union.

However, given the severity of the crisis, some form of banking and fiscal union is now almost inevitable. Germany's brinkmanship is clearly an effort to wrest all possible concessions from the peripheral and other Eurozone economies and get a deal with the lowest potential cost for the German tax payer. Given Germany's commitment to keep the Eurozone intact, it is certain that it will chip in with whatever it takes to achieve that.

Wednesday, June 27, 2012

It is now widely acknowledged that economies, howsoever strong their fundamentals, cannot remain insulated from negative global economic shocks. In simple terms, this means that irrespective of the domestic strength and size of an economy, adverse global economic events have the potential to generate macroeconomic distortions that can destabilize the economy. A fundamentally strong economy can, in quick time, become a victim of global economic events for essentially no fault of its.

Floyd Norris highlights the latest example of an economy, Switzerland, that appears to be falling victim to a crisis that it had no role in fuelling. As the Eurozone crisis progressed, investors searching for safety found in Switzerland and the Swiss franc an attractive safe haven. The country had stayed away from the Eurozone, had deep financial markets, and reasonably strong economic fundamentals.

Capital flowed in massive quantities, driving up the Swiss franc which appreciated spectacularly from its long-term stable value of around 1.4 francs to a euro to almost being on par with the euro. The Swiss central bank responded by publicly committing to not let the franc fall below 1.2 to a euro. It undertook massive purchases of euros, accummulating huge euro reserves. It also lowered Swiss interest rates to nearly zero. But despite all this, the Swiss economy has not been able to stave off the effects of the capital inflows. The declining external competitiveness has driven down exports, a consumption boom has been triggered, and a real estate bubble is rapidly inflating.

One cannot but not wonder whether Switzerland is actually paying a penalty for running its economy reasonably well! In many respects, Switzerland is facing the same challenges which many of the peripheral Eurozone economies, albeit with much less strong fundamentals, faced when they experienced a massive capital rush, again for different reasons, in the aftermath of the currency union.

As I have blogged earlier, the crisis in countries like Spain and Ireland is not the result of government fiscal profligacy but of Eurozone-wide macroeconomic forces unleashed in the aftermath of the monetary union. These countries, with relatively strong economic fundamentals, experienced a sudden and sharp lowering of borrowing costs and massive capital inflows, both of which led resource misallocation distortions and imbalances.

All this once again highlights the importance of macroeconomic regulatory oversight in a globalized economy. If, some years down the line, Switzerland is forced to confront an economic crisis triggered off by a real estate bubble and its attendant larger macroeconomy and financial markets distortions, several questions will be asked about what the Swiss government could have done to avoid the fate. This becomes all the more so since, if that happens, it would be virtual repeat of the problems currently being faced by the peripheral economies.

In fact a recent working paper by Marie-Aimée Tourres points to the success of India and China with use of capital controls to curb dangerous capital flows. She argues that "capital controls help to provide short-term monetary policy
independence within the impossible trinity and that long-standing
capital controls is possible leading to a mid-way path". I cannot but not be in greater agreement.

Certain essential functions like the provision of primary healthcare, school education, law and order maintenance, mass transit, and so on are indisputably better provided by governments. Other basic civic infrastructure services like water and sewerage, solid waste management, roads and bridges etc too are more efficiently serviced by governments. However, especially in developing countries, it may be desirable that some other services like provision of urban housing, railways, and all infrastructure services to rural interiors etc be delivered through governments.

In all these sectors, the concern is not so much with privatization per se as much as the absence of associated conditions which are a pre-requisite for the success of such private contracting. In all these cases, invariably the market is populated by one or two service providers, who hold virtual monopoly bargaining power over the government. If you call tenders for many of these services, you will be lucky to get more than two bids. Further, given the genuine risks associated with such contracts, the contractors rightly hedge for them. This in turn translates into higher prices and public expenditures. As I blogged earlier, most such outsourcing contracts, if contracted out properly, will involve much higher expenditures than when being run directly by the government.

Such markets invariably fail the Econ 101 test of "competitive markets". Neither is the supply-side strong enough to keep everyone honest, nor is the demand-side broad enough to support a market where cost recovery is possible without government subsidies. Exacerbating the problem is the lack of adequate capacity within the regulatory and administrative bureaucracies to effectively manage and monitor such contracts. In such conditions there are only two possibilities. One, private participants game the market rules and get away with poor quality service delivery, and most often with handsome profits. Two, government provides subsidy support or ends up internalizing some of the privately inflicted costs, thereby leading to accusations of crony capitalism.

All these risks are amplified in the case of developing economy markets. The supply-side is non-competitive and rent-seeking, demand side is uncertain and often inadequate, regulatory provisions incomplete and mostly difficult to enforce, political and social support unsure, and so on. The inherently long-term nature of many such service contracts and its control over scarce public resources/assets makes such contracts attractive acquisitions.

In this context, of equal, if not greater, relevance is the corrosive results of such privatization. Krugman points to the "corrupt nexus of privatization and patronage that is undermining government" across countries. There is nothing surprising with such outcomes given all the aforementioned problems and attendant risks associated with such sectors. Atleast in the initial stages, without considerable government support, none of the credible and long-term private firms are likely to bid. This would leave the door open for fly-by-night operators who are more interested in asset stripping, knocking away public resources cheaply, and profiteering by cutting corners on quality, safety, and environmental standards.

Post-liberalization India, especially with the recent spate of corruption scandals, is a picture perfect illustration of this thesis.

Sunday, June 24, 2012

Simon Johnson has an excellent summary in Economix of how Europe fell into the current mess. Deserves to be quoted at length. He writes,

The underlying problem in the euro area is the exchange rate system
itself – the fact that these European countries locked themselves into
an initial exchange rate, i.e., the relative price of their currencies,
and promised never to change that exchange rate. This amounted to a very
big bet that their economies would converge in productivity – that the
Greeks (and others in what we now call the "periphery") would, in
effect, become more like the Germans.

Alternatively, if the economies did not converge, the implicit
presumption was that people would move; Greek workers would go to
Germany and converge to German productivity levels by working in
factories and offices there... In
fact, the opposite happened. The gap between German and Greek (and
other peripheral country) productivity increased, rather than decreased,
over the last decade. Germany, as a result, developed a large surplus
on its current account – meaning that it exports more than it imports.

The
other countries, including Greece, Spain, Portugal and Ireland, had
large current account deficits; they were buying more from the world
than they were selling. These deficits were financed by capital inflows
(including some from Germany but also through and from other countries). In
theory, these capital inflows could have helped peripheral Europe
invest, become more productive and "catch up" with Germany. In practice,
the capital inflows, in the form of borrowing, created the pathologies
that now roil European markets.

In Greece, successive governments overspent – financed by borrowing — as they sought to stay popular and win elections... In Portugal and Italy, the problem is a longstanding lack of growth... As financial markets become skeptical of European sovereign debt, these
countries need to show that they can begin to grow steadily – and bring
down their debt relative to gross domestic product (something that has
not happened for the last decade or so)...

In Spain and Ireland, capital inflows – through borrowing by prominent banks – pumped up the housing market. The bursting of that bubble has shrunk their real economies and brought
down all the banks that gambled on loans to real estate developers and
construction companies. Their problems have little to do with fiscal
policy. As conventionally measured, both Ireland and Spain had responsible
fiscal policies during the boom, but they were building up big
contingent liabilities, in the form of irresponsible banking practices.

Greece and Portugal are relatively poor, with GDP per capita of 82
and 77 percent, respectively, of the EU average; this means roughly 76
and 71 percent of the eurozone average, since the euro countries are a
bit richer than the EU as a whole. Meanwhile, Germany is at 120 percent
of the EU, or 112 percent of the EZ. But it’s no different, really, than the US situation. Alabama is at 74 percent of the US
average, Mississippi at 67, with New England and the Middle Atlantic
states at 118 and 116.

In other words, as far as underlying economic inequalities are concerned, the EZ is no worse than the US. The
difference, mainly, is that we think of ourselves as a nation, and
blithely accept fiscal measures that routinely transfer large sums to
the poorer states without even thinking of it as a regional issue — in
fact, the states that are effectively on the dole tend to vote
Republican and imagine themselves deeply self-reliant.

Most of the major developed economies are yet to recover from the depths of the Great Recession. In fact, as the graphic highlights, except Canada, Belgium, US and Germany, none of the rest have regained their pre-crisis GDP level.

The fact that it is almost four-and-half years since the Great Recession struck makes this one of the longest periods of sustained economic weakness since the Great Depression. The labour market conditions mirror the GDP levels, thereby causing untold human suffering. With private sector in no position to lead growth, creditors still wary of lending, and household and business balance sheets debt-laden, government remains the only agent capable of kick-starting growth. But the fervour with which austerity is being promoted means that the only engine of growth is yet to be turned on full throttle.

Times (via Mostly Economics) points to an interesting experiment being conducted in Stanford University to lower traffic congestion by providing incentives to vehicle users to shift their commute to off-peak times.

Since early this year, Stanford Professor, Balaji Prabhakar and his group, Congestion and Parking Relief Incentives (Capri), have been experimenting with a scheme to declog the University's notoriously congested campus. The scheme, supported by a $3 million research grant by the US Department of Transportation, allows vehicle owners at the University campus to enter a daily lottery, with a chance to win up to an extra $50 in their
paycheck, just by shifting their commute to off-peak times. An early variant of this was tried out by the same group at an Infosys campus in Bangalore.

Early results appear to indicate that the voluntary scheme has been a success, both in terms of reducing travel times considerably and also attracting users. Instead of relying on the expensive physical infrastructure like sensors and RFID tag (like with congestion pricing), the Staford experiment uses the smartphones and location-tracking devices in the users vehicles. It uses the finely grained information on space and time from these user devices to set up a centralized web-based service to manage the incentives campaign.

However, Matthew Kahn raises important questions about the sustainability of such incentives. He contrasts incentive schemes with the polluter pays principle based congestion pricing. In the former, the payouts come in the form of a public subsidy (even with all the attendant benefits of reducing congestion) whose burden will only increase as the program gets scaled up. He also points to the difficulty of separating those who have shifted to off-peak hours from those who were anyways going to travel during those times.

Further, it can also be argued that the incentives possible under any such scheme when scaled up are too small for it to achieve significant changes in the commute behaviour. However, supporters argue that with congestion pricing facing political opposition in many places, such voluntary schemes may be the best possible way to introduce incentives into traffic management.

Prof Prabhakar has also developed a similar incentives-based program to encourage walking (to improve health) among Accenture employees. The scheme, called “Steptacular,” uses pedometers to measure the number of footsteps
more than 3,000 employees took each day. It also includes a social network component and a Web-based game to add a
random element to the incentives and has handed out $238,000 in rewards.

Friday, June 22, 2012

Even as the meter manufacturers and Government of India struggle with the development of a single metering standard for ensuring inter-operability of different meter manufacturers, the Green Button program in the US offers an excellent example of policy initiative that can define standards in an emerging industry.

Green Button is the common-sense idea that electricity customers
should be able to securely download their own easy-to-understand energy
usage information from their utility or electricity supplier. Armed with
this information, consumers can use a growing array of new web and
smartphone tools to make more informed energy decisions, optimize the
size and cost-effectiveness of solar panels for their home, or verify
that energy-efficiency retrofit investments are performing as promised.
Consumers can even use fun innovative apps that allow individuals to
compete against Facebook friends to save energy and lower their carbon
emissions.

The program, launched in early January 2012, is now being offered by many major electricity and gas distribution companies in the US on their respective websites. It is an industry-led program is based on a
common technical standard developed in collaboration with a
public-private partnership supported by the Commerce Department's
National Institute of Standards and Technology.

Its voluntary adoption by utilities across the country "allows software
developers and other entrepreneurs to leverage a sufficiently large
market to support the creation of innovative applications that can help
consumers make the most of their energy usage information". It will help consumers choose the most economical rate plan for their use
patterns; deliver customized energy-efficiency tips; provide easy-to-use
tools to size and finance rooftop solar panels; and conduct virtual
energy audits that can cut costs for building owners and speed the
initiation of retrofits.

The impressive acheivement here is the voluntary getting together of distribution utilities and their embrace of a standard which will help consumers compare between different suppliers. Government played an important role in facilitating this process in helping define the standards. A similar initiative will be extremely useful in financial sector, especially in the market for retail insurance and savings instruments.

Wednesday, June 20, 2012

Microinsurance, which is the provision of insurance against specific perils to low income people, has the potential to follow mirco-credit and emerge as the next big business opportunity at the bottom of the pyramid in the financial sector. Microinsurance products which insure for healthcare and death, when combined with an investment opportunity, offer several attractions for low income people.

In India, since 2002 (with subsequent amendments) the Insurance Regulatory and Development Authority (IRDA) has mandated that all insurers provide a specific share of their policies in rural areas and social sectors. Insurers are required to provide 7% of new life insurance policies from rural areas from their first year and this quota rises to 20% over ten years. Currently there are 6 million such life insurance policies and 10 million in non-life insurance policies. The Indian microinsurance market is estimated at between 140-300 million policies.

This policy mandate has played an important role in forcing insurance companies into rural areas and the low income people. This is all the more so given the meagre penetration of insurance products in India, the ample opportunities available for insurers from marketing their products to those in cities and at the upper half of the income ladder, and the high transaction costs associated with selling low value insurance to the poor in rural areas. But it has led to some innovative business models, where insurance providers have sought to leverage microcredit agencies and mobile phones to peddle their insurance products.

But such regulations also create distortions as insurers try to game the market to avoid meeting their obligations. Some insurers offer products which are not customized to add value to the poor and are merely to meet the regulatory requirements, while others stop selling it once they meet their quota. The major share of insurers have no incentive to innovate and see it as an issue of regulatory compliance.

In the circumstances, a more effective strategy to achieving the objective would be to allow tradeable permits in such policies. The IRDA should permit insurers to meet their quotas either directly or by buying permits from the other insurers who specialize in microinsurance or those with surplus policies. This will in turn catalyze a niche market with specialized microinsurance products and which has fewer market distortions and where insurers have greater incentive to innovate and expand their market shares.

Tuesday, June 19, 2012

In its mid-quarterly monetary policy review, the Reserve Bank of India (RBI) has decided to stay the course by keeping rates unchanged. In the backdrop of the recent dismal fourth quarterly GDP figures, the government, businesses, and severalinfluential voices have been arguing that the high interest rates are adversely affecting growth. They, therefore, strongly advocate rate cuts to boost economic growth.

However, there are also several factors militating against any rate cuts. Primarily,
real rates are lower than at any time in recent years. Core inflation
has fallen below 5% and is on a downward trend. Further, the
depreciating rupee, by making exports attractive and imports costlier,
too has added to the inflationary pressures. Most importantly, the headline WPI based inflation rose to 7.55%
in May from 7.23% in April, on the back of rise in prices of
manufactured products, fuel and power and non-food primary goods. In addition, retail inflation too has been rising, lending credence to the view that inflationary expectations are not fully anchored.

But there is a danger in persisting with tight monetary policy. Econ 101 teaches us that inflation can be either cost-push or demand-pull. In the former, negative supply shocks and other supply constraining factors contribute to increase in prices. In such conditions, interest rates can play very limited role in lowering inflation. In the latter case, inflationary pressures arise due to aggregate supply failing to keep pace with aggregate demand. Here, raising interest rates can help restrain demand growth and thereby lower inflation.

The RBI's tight monetary policy stance since early 2009 has been dictated by the belief that inflationary pressures were being caused by demand-pull factors arising from an overheating economy where supply-side bottlenecks had become prominent. This necessitated raising interest rates so as to lower economic growth rates to sustainable levels. This strategy has worked nicely in terms of moderating growth and even bringing down inflation from its double digit levels of 2010.

However, now with growth having fallen well below the potential output (and thereby having attentuated the demand-pull forces), the potential for tight monetary policy to reduce inflation may be limited. In fact, high interest rates may be having the effect of restraining investments and thereby perpetuating the supply constraints. In other words, inflationary pressures may be getting built up by way of the higher interest rates discouraging investments.

If inflationary pressures are indeed being stoked through this channel, as they could be, then the RBI risks falling behind the curve. The downside risk of this is the possibility of an economy getting trapped in a stagflationary environment with high inflation and declining growth rates. Political paralysis will only compound the problems. A recovery from such situation may not be easy.

Hindsight may be the only way in which we can satisfactorily resolve the
argument about which of the two, inflation or growth, is a greater problem
facing the Indian economy at this point in time.

In any case, having decided to go along with the inflationary-forces-are-still-at-large hypothesis, the best that the RBI can now do is to wait for the first quarter 2012-13 GDP figures. If they do not show marked improvement, the RBI would need to moderate its inflation fighting stance and embrace monetary loosening before it becomes too late to stop a free-fall or self fulfilling downward spiral.

Another interesting feature is the fundamental difference between the respective policy approaches adopted by the RBI and the US Federal Reserve when faced with weak economic conditions. For sure, inflationary environments in India and the US stand at the two extremes. But whereas the Fed has thrown every instrument in the monetary policy arsenal so as to prevent the economy slipping into a deflationary trap, the RBI has been more circumspect about growth and has preferred to focus on inflation, even at the risk of worsening stagflation.

Whatever, the final outcome, the RBI should be complimented for sticking to its inflation-fighting strategy, even in the face of such overwhelming calls for rate cuts from the markets and the government. It is also a clear signal to the markets about its relative autonomy and a boost to its institutional credibility. In some sense, when we look back in history, the global economic tumult of the past five years may well be recorded as the time when the RBI earned its central banking spurs as a genuinely independent and professional central bank.

Monday, June 18, 2012

Official auditors in India appear to have been bitten by the discounted cash flow (DCF) analysis bug. Ever since the news of the Rs 1,76,000 Cr loss causing 2G spectrum scandal broke out, auditors have realized the populist appeal of such assessments. The temptation to scrutinize every resource allotment decision exclusively through the lens of expected future cash flows is irresistible.

This auditing formula is simple. Scarce and valuable revenue generating public resources have been allocated on preferential basis at concessional rates, allegedly in return for massive amounts of bribes. These resources, when subjected to standard DCF analysis, are estimated to have benefited the private allottees with massive revenues (and profits) running into several decades. The net present value (NPV) of these future cash flows is calculated at the current market price of the resource. The allotment price is deducted from the NPV and the difference is declared as revenues foregone and resultant loss caused to public exchequer.

The latest in the series of such auditor discovered scams is the development rights of the New Delhi airport allotted on concessional terms. The Comptroller
and Auditor-General (CAG) claims that Delhi International Airport Ltd (DIAL) could earn up to Rs1,636 tr ($29bn) over 60
years from using government land leased at an annual ground rent of just
Rs 100, on top of a one-time payment of $ 324m.

Auditors who put such valuations at the center of their exercise risk
simplifying very complex business problems. Even assuming such auditing
reports (any audit is after all based on certain assumptions and
formulas), it is surely irresponsible for responsible people analyzing
these reports to take such assessment at face value to the near total exclusion of all other factors. If the mainstream debate on complex and multi-dimensional policy issues is driven by such DCF-based revenues foregone assessments, policy populism and decision paralysis become inevitable.

In recent months, there have been three high-profile instances of policy populism in very important areas. First was the draft mining bill, second the land acquisition bill, and the last related to the revised 2G spectrum auction process.

Mineral exploration and extraction has been the subject of intense scrutiny due to both the corruption involved and its environmental and social costs. In the prevailing discretionary, first-come-first-serve basis mining block allotment regime, price discovery was always a problem. The lack of clear policy regime and uncertainty associated with environmental and other clearances made this a very risky activity for prospective developers. In addition, since most of these mines are in the remote forests and interior parts, such mining activity invariably affects the lifestyles and livelihoods of tribals and other indigenous people. The sensational CAG report which alleged a $210 bn scam in preferential mine allotments and widespread environmental and local opposition to mining activity in any area drove the government into formulating a new mining policy.

It was, as part of this populist drive, that the government announced the "no-go" areas policy in mid-2010, which barred mining in many major coal bearing areas on environmental grounds. The move blocked the development of 203 coal blocks with reserves of a 660 mt – enough to
fire a power generation capacity of 130,000 MW. Though this has been done away with, the Environment Ministry is now working on demarcating "inviolate areas" where mining will be prohibited due to high forest cover.

A few high profile cases of forcible land acquisition by government to build public infrastructure assets or to benefit private parties, like with the Special Economic Zones or Singur or Nandigram, saw a series of often violent protests by land losers in many parts of the country.The fundamental political rallying point was that it was plain unfair for the government to use its eminent domain powers to dispossess rural poor from their primary livelihood source, land, in the name of development. There was a clamour to replace the century-old Land Acquisition Act 1894, which in any case had other stifling provisions.

In response the Union Government drafted a land acquisition bill that swerved to the other extreme. Its provisions include payment of compensation that is four times the highest registered sale price in the last three years in that area, mandatory consent of 80% of people in those cases of acquisition where the land is to be given to private parties, those made "landless" to get Rs 2000 per month for 20 years, emergency acquisition clause to be invoked only when security of the people is involved, and so on. The recommendations of the Parliamentary Standing Committee includes the payment of five times the market price of land acquired, returning 20 per cent
developed land to the owner, job guarantee for next 20 years, and 70 per cent consent
of land owners for any acquisition for commercial purposes.

The Land Acquisition, Rehabilitation and Resettlement Bill 2011 (LARR) is currently awaiting parliamentary nod before being promulgated into law. And even this fairly generous bill is being rubbished as being too little. Even a cursory reading would indicate that the draft bill goes much beyond the basic requirement of fairness in compensation and relief and rehabilitation package, and clarity in the definition of "public purpose".

Not to be outdone, while scrutinizing the TRAI proposal, the Department of Telecom (DoT) went one step further and hiked the reserve price by a further 17% to Rs 4,245 crore per unit. It also rejected the TRAI's proposal to allow telcos to stagger payments for spectrum over
a 12-year period and the permission for telcos to mortgage spectrum to raise funds from
financial institutions. The clarification by DoT officials on the rationale for the price fixation was revealing,

TRAI had determined the reserve price in the 1800 MHz band based on the
3G auction price of 2010. We feel that 3G auction price must be indexed
for a period of two years to determine the present value of spectrum.
During this period, State Bank of India's PLR rates have been between
11.75-14.75% and therefore the revised figure works out to Rs 4,245
crore for every unit of 2G spectrum in the 1800 MHz band.

Consider this. There is already enough evidence that the telecos over-paid during the 3G auctions and therefore a more efficient spectrum price should be lower. Instead, the DoT does a simple linear extrapolation of prices on the auction price, and that too based on the prevailing bank lending rates. Furthermore, influential sections within the government view such auctions as a convenient and costless way to raise resources to bridge fiscal gaps.

There are three concerns with such populism. One, when eye-popping figures like Rs 1,760 trillion or Rs 1,636 trillion are so
casually bandied about, it does tend to focus attention on the sensational issue of bringing those responsible to light while glossing
over the more important task of systemic changes that can sustainably
prevent the recurrence of such scams. This is clearly evident in the
aftermath of the 2G spectrum scandal when the focus was on implicating
and punishing those accused. A great opportunity to put in place
effective mechanisms to manage allotments of public resources has been
missed.

Two, such highly simplistic assessment of loss caused to
public exchequer based on DCF analysis of revenue flows, priced at
prevailing market prices, immediately puts public servants on their
guard. It completely divorces all other practical real world problems,
challenges, and risks in such business decisions and encourages public officials to avoid pricing
them into contracts. The result is still-born markets and contracts, and
possibly even more corruption.

Three, they tend to mix often conflicting priorities. The primary objective of the mining and telecom bills ought to be the regulation of two critical sectors, so as to eliminate policy uncertainties and enable their efficient development. However, influential sections within the government tend to view them as excellent resource mobilization opportunities that can bridge the government's fiscal imbalances. Alternatively, they are also viewed as opportunities to expand the government's
social programmes, like in case of the mining bill to the huge tribal belts of the country and generate
funds for local development in such areas.

It is obvious that such mechanistic, but procedurally safe, and financial returns maximizing, decision-making on such important policy issues is the inevitable result of the extreme vitiation of the political and bureaucratic environment in the aftermath of the spate of recent resource allocation scams. It cannot be denied that these revelations have provided the much needed wake-up call to begin cleansing public life off corrupt practices that had spiralled out of control.

However, its collateral damage has severely debilitated the policy making apparatus. It has induced a form of decision-paralysis and play-safe attitude among officials and even political representatives at all levels. The biggest casualty in the process is likely to be economic growth in general, and the development of these sectors in particular.

Sunday, June 17, 2012

Excellent graphic (from The Economic Crisis, via Frances Woolley, via Mark Thoma) about how fear and contagion has erupted across the Eurozone and how the EMU Project contributed to the artificial supression of sovereign risk in its members. I have blogged earlier about how over a four year-period, beginning 1995, the bond yields more than
halved and converged around 4% across most of the eurozone economies.

As the pre-EMU Greek bond yields indicate, the low borrowing costs enjoyed by Greece for many years now had merely papered over serious structural inefficiencies. Now these unattended problems are resurfacing with some vengeance as risk gets re-priced at its original level.

See also this report on how the Chinese have stormed the manufacturing sector over the past two decades.This NYT report examines the recent trend of many traditionally outsourced activities now returning back to the US.

Saturday, June 16, 2012

I have blogged and written earlier about how Singapore uses Certificate of Entitlement (COE) quotas to restrict vehicle ownership growth by mandating that all new vehicle owners buy COE permits in
auctions. The high COE permit auction rates are expected to act as a prohibitive tax on
vehicle ownership.

At S$86,889 ($67,000) just for a permit, the total price of
a Volkswagen Passat in Singapore is about the same as the median US metropolitan home. A 25 percent jump in residents in seven
years, coupled with the world’s highest proportion of
millionaire households, has fueled a 10-fold surge in license
prices over three years...

A new 2012 Passat sedan made by Volkswagen AG (VOW), the world’s
second-largest carmaker, costs about $152,000 in Singapore,
including the license... The median price of a U.S. metropolitan area home
is $158,100, National Association of Realtors data show.

So-called open-category permit, which can be used to buy
any type of vehicle, reached S$92,010 in April, the highest
since the end of 1994 when a record of S$110,500 was reached. At
the latest auction May 23, the licenses went for S$86,889,
compared with S$8,501 three years ago. The permits give the
right to own a car for 10 years. The next auction is tomorrow. Besides having to bid for certificates at auctions that are
held every two weeks, Singaporeans also pay registration fees
and taxes that can amount to 150 percent of the market value of
a vehicle

Now, if this were India, atleast two things would have happened to derail the COE permit system. One, the populist backlash surrounding the steep rise in COE prices would have been enough to force the government to abort the system. Two, the magnitude of the tax would have triggered off a rush to game the system. Either ways, such a stringent COE permit system would have struggled to survive in India.

In countries like India, a more effective strategy would be to use multiple instruments aimed at discouraging both vehicle ownership and usage, the cumulative cost of all of which would reduce private vehicles on our roads. Apart from others, they should include a less stringent COE type system. Most importantly, a very good public transit system is an essential requirement for the success of any such intervention.

Update 1 (5/9/2012)

The NYT reports that the municipal government of Guangzhou, a sprawling metropolis that is
one of China’s biggest auto manufacturing centers, introduced license
plate auctions and lotteries last week that will roughly halve the
number of new cars on the streets.

But the bigger interest is on whether the Fed will step in with a third round of quantitative easing. Supporters argue that the Fed still has considerable fire power to credibly commit to keeping interest rates low for a sustained period of time, much longer than what is being done now.

However, there are reasons to doubt whether further loosening will be of any benefit. Given the bruised household balancesheets and anemic investment climate, the monetary base expansion is piling up as banks' reserves instead of being lend for consumption and investment. In a recent op-ed Lawrence Summers summed it up nicely,

However, one has to wonder how much investment businesses
are unwilling to undertake at extraordinarily low interest rates that
they would be willing to undertake with rates reduced by yet another 25
or 50 basis points. It is also worth querying the quality of projects
that businesses judge unprofitable at a -60 basis point real interest
rate but choose to undertake at a still more negative real interest
rate. There is also the question of whether extremely low safe real
interest rates promote bubbles of various kinds.

There is also an oddity in this renewed emphasis on
quantitative easing. The essential aim of such policies is to shorten
the debt held by the public or issued by the consolidated public sector
comprising both the government and central bank. Any rational chief
financial officer in the private sector would see this as a moment to
extend debt maturities and lock in low rates – exactly the opposite of
what central banks are doing. In the U.S. Treasury, for example,
discussions of debt-management policy have had exactly this emphasis.
But the Treasury does not alone control the maturity of debt when the
central bank is active in all debt markets.

Further, any quantitative easing runs significant risks. As I have bloggedearlier, the ultra-low interest rates have generated several resource mis-allocation problems. A bond market bubble in safe haven assets, induced by the flight to safety and liquidity, is inflating. The corollary to this is the mirror image reversal of rising yields associated with the vulnerable economies. Managing the exit from such mismatches throws up another set of problems.

Thursday, June 14, 2012

Mumbai has perhaps the most extreme statistics of any metropolis. Its
land mass is small, stuck like a crooked blade into the Arabian Sea. It
has poor transport links, so people who work in the city live near it.
That in turn means it has the highest population density of any big
city. But it is also low-rise. Panama City has a taller skyline.

The result is tiny living spaces of 4.5 square metres (48 square
feet) per person, compared with 34 square metres in Shanghai. And prices
are high. Mid-town flats cost $1m-3m. The average price of a
1,000-square-foot pad in the city is perhaps $250,000, or 90 times GDP
per head. With flats out of reach, the share of people in slums has
risen to perhaps 60%, compared with 20% in Rio de Janeiro and Delhi. Of
the rest, about half live in rent-controlled digs, sometimes propped up
by wooden staves, or flats for public-sector employees.

Two regulatory restraints - floor area ratio (FAR) restrictions and rent control regulation - are the biggest impediments to expanding supply and thereby lowering prices. Given the massive demand, rapidly growing immigration, and virtually depleted shelf of vacant lands, the only way to generate built-up space for accommodation is to go up vertically by redevelopment of existing units. Any other reform has to revolve around these two fundamental changes. Till they are addressed, Mumbai will suffer from the twin-curse of inadequate and unaffordable residential space.

I have already blogged, here and here, about the adverse consquences of the FAR restrictions and how it compares with cities elsewhere in the world. The impact of the Rent Control Act has been no less debilitating. Of Mumbai's approximately 16142 rent-controlled properties, more than 5000 are older than 100 years and only 3% of all the rent-controlled units have been redeveloped so far.

For a variety of reasons, FAR restrictions continue to rule the roost. However there is hope that the old rent control regulations could soon be reformed. The Government of India have mandated that reforms to rent control legislations, in line with a modelResidential Tenancy Act 2011, is a precondition for states to access funding under the Rajiv Away Yojana (RAY) project which provides massive central government grants for urban housing an slum redevelopment.

There is the successful precedent of repeal of the Urban Land Ceiling Act in many states as a precondition to receiving funding under the JNNURM. But the populist nature of the debate surrounding any repeal of rent control, in so far as it would impact large numbers of tenants paying paltry rents for decades, will be a formidable obstacle to this reform.